Restoring Financial Stability

418 Pages·2010·2.92 MB·English

by  Acharya, Viral V.

Praise for R WILEY FINANCE $49.95 USA / $59.95 CAN
R e s t o r i n g Fi n a n c i a l S t a b i l i t y i
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“The Stern School faculty is making an important contribution to the needed debate about r a
d r The fi nancial crisis that unfolded in September
how to go about reforming our broken fi nancial system. Plainly, the insights of fi nancial
s y R E S T O R I N G
theory need to be better adapted to the practical requirements of maintaining reasonable o a 2008 transformed the United States and world
stability of markets and institutions. Restoring Financial Stability: How to Repair a Failed n economies. As each day’s headlines brought stories
System helps point the way.” of bank failures and rescues, government policies
VIRAL V. ACHARYA is Professor of Finance at
—Paul Volcker, Chairman of Economic Recovery Advisory Board and former R drawn and redrawn against the backdrop of an
New York University Stern School of Business and
Chairman of the Federal Reserve (1979–1987)
E historic presidential election, and solutions that
London Business School. He is Academic Advisor
seemed to be discarded almost as soon as they were
to the Federal Reserve Banks of New York and “Although we are yet in the midst of a gigantic global fi nancial crisis, the academics who S F I N A N C I A L
proposed, a group of thirty-three academics at New
Philadelphia and Academic Director of the Coller contributed to this timely and comprehensive compendium have provided us with not T
only an excellent analysis on each topic, but also timely recommendations as to how to York University Stern School of Business began
Institute of Private Equity. Professor Acharya earned O
move forward responsibly to develop the next generation of our fi nancial-service industry tackling the hard questions behind the headlines.
a Bachelor of Technology in computer science and
architecture.” R Representing fi elds of fi nance, economics, and
engineering from the Indian Institute of Technology,
—Myron Scholes, Chairman of Platinum Grove Asset Management and I accounting, these professors—led by Dean Thomas
Mumbai, and a PhD in fi nance from NYU Stern. N
winner of the 1997 Nobel Prize in Economics Cooley and Vice Dean Ingo Walter—shaped eighteen
He lives in New York City with his wife and son.
H G independent policy papers that proposed market-
“The authors provide important perspectives on both the causes of the global fi nancial crisis o B I
MATTHEW RICHARDSON is the Charles E. Simon as well as proposed solutions to ensure it doesn’t happen again. A must-read for anyone w S T A focused solutions to the problems within a common
Professor of Financial Economics and the Sidney interested or involved in the fi nancial markets.” to F L I T Y framework. In December, with great urgency, they

R I sent hand-bound copies to Washington.
Homer Director of the Salomon Center for the Study —John Paulson, President and founder of Paulson & Co, Inc. e N
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of Financial Institutions at New York University
a A
“No sustainable economic recovery can take hold until our tattered fi nancial system is not i This book, Restoring Financial Stability: How to
Stern School of Business. Professor Richardson r
just repaired but, more importantly, until its institutional framework is restructured and new a N Repair a Failed System, is the culmination of their
received his PhD in fi nance from Stanford University rules of fi nancial behavior are put in place. This book, the work of prominent academicians F work. For policymakers and business executives
and his MA and BA in economics concurrently from a C
from a leading school of business, makes an important contribution to the framing of the
il alike, the book proposes bold ideas—fi nancial
the University of California at Los Angeles. He lives problems and provides specifi c recommendations for their solutions. What makes this book e I
d A policy alternatives and specifi c courses of action—
in New York City with his wife and three children. especially valuable is its detailed evaluations and analyses covering many spectrums of the
S
marketplace.” y L to deal with this unprecedented, systemic fi nancial
s
crisis. Their remedies acknowledge the power and
—Henry Kaufman, President of Henry Kaufman & Co., Inc. t
e
m S potential of the free market. Some require modest
“This book consists of a set of papers providing a comprehensive and incisive analysis of regulatory intervention; others will shake regulatory
T
perhaps the greatest crisis to hit the capitalist system in recent times. The papers are by re- A Failed System practice to its very foundation.
nowned experts in the area. Together, they constitute an indispensable read for anyone inter- How to Repair a
B
ested in understanding the roots of the crisis and trying to formulate policies to resolve it.”
To better understand the origins of the current
—Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance, I
L fi nancial crisis as well as the options for restoring
Jacket Design: Michael J. Freeland Chicago Booth School of Business, and former Chief Economist
fi nancial health, don’t miss this important and
Jacket Image: © Jupiter Images at the International Monetary Fund (2003–2006) I
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timely work. Edited by Viral Acharya and Matthew
Y Richardson, this reliable resource brings together
Viral V. Acharya
the best thinking of fi nance and economics faculty
from one of the top universities in world.
Matthew Richardson
e d i t o r s
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Restoring
Financial
Stability
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Restoring
Financial
Stability
How to Repair a Failed System
VIRAL V. ACHARYA
MATTHEW RICHARDSON
John Wiley & Sons, Inc.
iii
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Copyright(cid:1)C 2009byNewYorkUniversitySternSchoolofBusiness.Allrightsreserved.
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LibraryofCongressCataloging-in-PublicationData:
Restoringfinancialstability:howtorepairafailedsystem/ViralV.Acharyaand
MatthewRichardson,editors.
p. cm.—(Wileyfinanceseries)
Includesbibliographicalreferencesandindex.
ISBN978-0-470-49934-4(cloth)
1. Finance—UnitedStates. 2. Financialcrises—Governmentpolicy—UnitedStates.
3. Banksandbanking—UnitedStates. 4. Financialservicesindustry—UnitedStates.
5. UnitedStates—Economicconditions—2001– I. Acharya,ViralV. II. Richardson,
Matthew,1964–
HG181.R37 2009
339.50973—dc22 2009004115
PrintedintheUnitedStatesofAmerica
10 9 8 7 6 5 4 3 2 1
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To Manjiree
—V.V.A.
To my best friend and love of my life, Julie, and
our three wonders, Jack, Charlie, and Lucas.
—M.R.
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Contents
Foreword xi
Acknowledgments xiii
PROLOGUE:ABIRD’S-EYEVIEW
TheFinancialCrisisof2007–2009:CausesandRemedies 1
ViralV.Acharya,ThomasPhilippon,MatthewRichardson,
andNourielRoubini
PARTONE
CausesoftheFinancialCrisisof2007–2009 57
MatthewRichardson
CHAPTER1
MortgageOriginationandSecuritizationintheFinancialCrisis 61
DwightJaffee,AnthonyW.Lynch,MatthewRichardson,
andStijnVanNieuwerburgh
CHAPTER2
HowBanksPlayedtheLeverageGame 83
ViralV.AcharyaandPhilippSchnabl
CHAPTER3
TheRatingAgencies:IsRegulationtheAnswer? 101
MatthewRichardsonandLawrenceJ.White
PARTTWO
FinancialInstitutions 117
MatthewRichardson
CHAPTER4
WhattoDoabouttheGovernment-SponsoredEnterprises? 121
DwightJaffee,MatthewRichardson,StijnVanNieuwerburgh,
LawrenceJ.White,andRobertE.Wright
vii
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viii CONTENTS
CHAPTER5
EnhancedRegulationofLarge,ComplexFinancialInstitutions 139
AnthonySaunders,RoyC.Smith,andIngoWalter
CHAPTER6
HedgeFundsintheAftermathoftheFinancialCrisis 157
StephenJ.Brown,MarcinKacperczyk,AlexanderLjungqvist,
AnthonyW.Lynch,LasseH.Pedersen,and
MatthewRichardson
PARTTHREE
Governance,Incentives,andFairValueAccountingOverview 179
ViralV.AcharyaandRangarajanK.Sundaram
CHAPTER7
CorporateGovernanceintheModernFinancialSector 185
ViralV.Acharya,JenniferN.Carpenter,XavierGabaix,
KoseJohn,MatthewRichardson,MartiG.Subrahmanyam,
RangarajanK.Sundaram,andEitanZemel
CHAPTER8
RethinkingCompensationinFinancialFirms 197
GianLucaClementi,ThomasF.Cooley,MatthewRichardson,
andIngoWalter
CHAPTER9
FairValueAccounting:PolicyIssuesRaisedbytheCreditCrunch 215
StephenG.Ryan
PARTFOUR
Derivatives,ShortSelling,andTransparency 229
ViralV.Acharya
CHAPTER10
Derivatives:TheUltimateFinancialInnovation 233
ViralV.Acharya,MenachemBrenner,RobertF.Engle,
AnthonyW.Lynch,andMatthewRichardson